First-tier Tribunal (Tax)

[2010] UKFTT 301 (TC)

TC00589

Appeal number: TC/2009/13558

Disposal of a substantial shareholding by a company - exemption from corporation tax under Sch 7AC TCGA 1992 – whether a non-compete agreement pursuant to share sale agreement and for which part of agreed share sale price had been apportioned should be treated as a separate sale or deemed disposal of goodwill and therefore taxable as a corporate chargeable gain under s.22 TCGA

FIRST-TIER TRIBUNAL

TAX

                         WILLIAMSON TEA HOLDINGS LIMITED        Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                                   REVENUE AND CUSTOMS               Respondents

                        TRIBUNAL: MICHAEL S CONNELL (TRIBUNAL JUDGE)

                                                SUSAN HEWETT (MEMBER)

Sitting in public at 45 Bedford Square,  London WC1B on 14 April 2010

Richard Bramwell QC for the Appellant

Kelvin Shorte instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2010

1.       This is an appeal by the Appellant against an amendment to its corporation tax return for the accounting period 01 April 2005 – 31 March 2006 made by HMRC pursuant to paragraph 34 Sch. 18 Finance Act 1998 on the basis that a payment of £3,768,038.00 paid to the Appellant under a ‘non-compete agreement’ was taxable as a capital sum derived from a disposal of goodwill by the Appellant within the meaning of TCGA 1992 section 22.

2.       The background to the appeal is that, until 16 June 2005, the Appellant owned the whole of the issued share capital in Borelli Tea Holdings Limited (‘Borelli’), a company incorporated in England and Wales. At the material time Borelli owned approximately 70% of the issued share capital of Williamson Tea Assam Limited (‘WTA’), a company incorporated in India and quoted on the Mumbai stock exchange.  The business of WTA was the operation of 17 tea plantations in India.

3.       By an agreement made on 16 June 2005 the Appellant agreed to sell its entire shareholding in Borelli to McLeod Russel India Limited (‘MRIL’) for £17,584,177.00.  The shares in WTA were the only asset of Borelli and the price paid for those shares implied a price of Rs 145 per share for the shares in WTA.  MRIL also indicated that it intended to offer to purchase up to 20% of the minority holdings in WTA at the same price per share – that is Rs 145. It was explained to the Tribunal by Mr Philip Magor the Chairman and Managing Director of the Appellant company that, under the Indian Takeover Regulations, an offer for a minority holdings could not be less than the implied price paid in respect of the control shareholding.  The sale of the shares in Borelli was accepted by HMRC as attracting the Substantial Shareholdings Exemption under TCGA 1992 Sch. 7AC.

4.       In the Share Sale Agreement the Appellant agreed to enter into a non-competition agreement (‘NCA’) with MRIL.  The consideration paid by MRIL for the Appellant entering into the NCA was £3,768,038.00 which had been calculated as £13.5528 per share of Borelli.  The sum paid under the NCA was treated by HMRC as a capital sum for the part-disposal of the Appellant’s goodwill.  In the Appellant’s Corporation Tax Return the sum paid under the NCA was not treated as a consideration received for the disposal of an asset.  Under the terms of TCGA 1992 s.22, the disposal of goodwill would be taxable.  Companies are chargeable to Corporation Tax in respect of chargeable gains accruing to them.

5.       The witness statement of Mr Magor sets out the background and structure of the transaction with Borelli and explains that the NCA was introduced by Borelli as a way of reducing the implied share sale price in WTA in order to reduce correspondingly the price payable to the minority shareholders in WTA.

6.       Negotiations over the price of the shares were conducted in terms of rupees per kilogram.  Mr Magor explained that is the convention in the tea business in India that the value of shares is arrived at by reference to the amount of tea produced by the business.  The price paid for the business was therefore expressed in terms of rupees per kilogram.  MRIL offered Rs 121 per kg.  The offer based on WTA productivity amounted to an overall price of £21.35m. This was the amount which it was agreed MRIL would pay for the shares.  The offer of £21.35m which was for a 70% interest in WTA implied the price of Rs 170 per share in WTA. 

7.       If the sum of £21.35m was to be paid to the Appellant, MRIL would be required to offer to buy the minority shareholdings at Rs 170 per share. It was therefore proposed that, by agreeing a price of around £17.58m for the shares and paying around £3.77m under an NCA, MRIL would be able to offer Rs 145 to the minority shareholders of WTA.  This represented a considerable saving to MRIL, which the Appellant was prepared to accommodate as in principle it made no difference to the amount of cash received by the Appellant for the transaction.  This was, Mr Magor said, entirely acceptable practise, within the rules of the Indian Takeover Regulations and, in effect, allowed a discount to the price paid to the minority shareholders of up to 20% of the price paid to the majority shareholder.  He said the practise of paying of premium to the majority shareholder by way of an NCA was raised not only in the context of the offer by MRIL but also in the context of another offer made by another potential purchaser.  Details of the various offers made for the majority shareholding in the Appellant company are set out in a memorandum lodged with Mr Magor’s witness statement dated 06 June 2005.

8.       Mr Magor explained the historical background and reasons why the Appellant company wished to divest itself of its interest in Borelli and that there was never any question of the Appellant company competing with WTA after the share sale.  Following the transaction the Appellant company had no other business interests in India, no goodwill, residual or otherwise and had no intention of re-entering the Indian market which in any event, having disposed of its interest in Borelli, would have been difficult.

9.       Mr Magor said that, in summary therefore, the NCA was purely an artificial device and that the combined price paid under the Share Purchase Agreement for the sale of the shares in Borelli and the NCA was in reality the price paid for the shares.  Although the price was split into two parts and formally ascribed in part to the shares and in part as a premium for the NCA, it was an entirely artificial device with a view to enabling MRIL to pay a lower price to the minority shareholders. 

10.    HMRC contended that, through its subsidiaries, the Appellant had established a worldwide reputation as finest quality tea wholesalers, dealers and suppliers and in consequence owned goodwill, part of which was its reputation in the territories covered by the NCA – India, Sri Lanka, Nepal and Bangladesh.  HMRC contended that the payment under the NCA was not part-consideration for the sale of the shares in Borelli and that, by entering into the NCA, the company turned the asset of goodwill to account by agreeing not to exploit its reputation in those territories for a defined period of time.  The basis of HMRC’s argument was that the Appellant had been involved in the tea trade in India for many years and undoubtedly owned an asset in the form of goodwill, including reputation and knowhow.  HMRC asserted that Kirby v Thorn EMI (60 TC 519) lays down the rule that any agreement not to compete involves a disposal of goodwill, which was accordingly chargeable under s.22 TCGA 1992.  HMRC’s conclusions were based on the proposition that it was established law that consideration for an agreement not to compete must be derived from goodwill.

11.    The Appellant argued that this was not a possible reading of Thorn and that in any event the Appellant had no goodwill in India.  The Appellant said it was clear from the contractual documentation and the manner in which the consideration for the NCA had been calculated that it was a disguised premium for the control holding in WTA held by Borelli with the result that, if s.22 applies, the NCA was derived from the shareholding in Borelli to which the Substantial Shareholding Exemption applied.

12.    The Appellant said that in Thorn, the court merely said that a payment not to compete may be derived from goodwill.  In the Thorn case, an intermediate holding company in the Thorn Group sold to ‘GE’ all its issued share capital in three subsidiary companies which traded as repairers of electrical motors and manufacturers of industrial lifting magnets.  As part of the sale agreement Thorn covenanted with GE that, in consideration of the payment of £315,934.00 by GE to Thorn, neither Thorn nor any of its subsidiaries would for 5 years engage in the trades carried on by the three subsidiary companies.  Thorn contended that a sum paid for the restriction of liberty to trade did not accrue on the disposal of an asset and therefore was not within the capital gains tax legislation.  Before the Special Commissioners and in the High Court, the Revenue relied on several arguments, none of which succeeded, but in the Court of Appeal raised a further argument that had not previously been advanced, being that, if there needed to be a pre-existing asset owned by Thorn for capital gains tax to apply, the goodwill of Thorn represented such an asset of which it could dispose in consideration of a sum paid for the restriction of liberty to trade.  Thorn submitted that it had no goodwill of which it could dispose by covenant or from which it could derive a capital sum because it did not carry on any of the trades in question and it had no goodwill in those trades.  Thorn said that curtailing its liberty to compete and trade was not a disposal of ‘property’.  Nicholls L J said that it was not necessarily established that the three subsidiaries had any relevant goodwill and that Thorn itself had no goodwill in respect of the trades in question.  However, he added that ‘failing cogent evidence to the contrary, it was an ‘inference’ naturally to be drawn’.  The point Nicholls L J was making was that, from the facts known to the court, the inference he mentioned could be drawn failing cogent evidence to the contrary.  However the Court of Appeal could reach no decision on the point because no opportunity had been given to Thorn to adduce the evidence in support of its argument.

13.    The Appellant therefore submitted that Thorn was not authority for the proposition that the Appellant must be taken to have been the owner of group goodwill and that the furthest Thorn went was to place an onus on the Appellant to show that the NCA was not derived from goodwill belonging to it.  The Appellant said that, in Scandecor Development AB, the Scandecor Marketing AB [1998] EWCA Civ 1282, the Court of Appeal held that ‘there is no rule of law that, or presumption of fact that, the goodwill generated by the trading activities of a wholly owned subsidiary belongs to the parent company’.

14.    HMRC argued that the fact that the NCA consideration was calculated by reference to an amount per share in Borelli did not determine its nature and purpose and referred to the case of Glenboig Union Fireclay Co Ltd v CIR (12 TC 247), saying the case was support for the proposition that the nature of the payment is determined by the documented reasons why payment was made and that in the present case the payment was made in return for the Appellant agreeing not to compete with MRIL under the NCA.  HMRC said the case of Spectros International plc v Madden (70 TC 349) sets out that, whilst parties are free to formulate agreements to suit their interests, it is not open to them to subsequently invite the court to adopt some other method because it is more advantageous.

15.    The Appellant responded that HMRC were addressing an argument that the Appellant did not advance.  The Appellant had never suggested that there should be a reconstitution of the documented contractual agreements.  The Appellant said it was clear from the factual basis upon which the NCA was introduced into the transaction that the consideration paid was not for goodwill, of which it had none, but for the shares in Borelli and that in consequence the deemed disposal under s.22 would be covered by the Substantial Shareholdings Exemption.

16.  The existence of goodwill is a question of fact. Whether it exists and its exact composition varies between different trades. Goodwill is in essence the difference between the value of tangible assets of the business and the purchase price. There may be a natural inference to be drawn that goodwill exists whenever parties enter into a NCA. The fact that goodwill is not referred to in a share sale agreement is not determinative in law that it has not been disposed of. It may consist of intangible factors such as reputation, customer base, production methods and expertise.  In the sale of a business as a going concern, if the terms of a non-compete agreement which affect the proprietor’s freedom to exploit the goodwill of the business, involve the payment of a capital sum, such capital sum would be regarded as derived from a disposal of goodwill and treated as a chargeable capital sum within s.22 TCGA 1992.  Thorn held that a non-compete agreement is prima facie evidence of the existence of goodwill and that it is for the taxpayer to displace the proposition.  In the event, the court in Thorn did not consider the capital sum to be derived from the restrictive covenant which it had entered into.  This case however was not the sale of a business as a going concern in which assets can be separately identified and disposed for an agreed consideration.  It was a share sale agreement. Goodwill may or may not have existed but, if it did exist, it would have been inherent in the share valuation and reflected in the share sale price agreed under the share sale agreement and, as such, subject to the substantial shareholder exemption.

17.       The factual information provided by the Appellants showed that the share valuation had been agreed pursuant to an accepted valuation methodology linked to average productivity over a number of years and HMRC had not shown that the overall total price of £21.35 million in the share sale agreement included an amount in excess of the true and fair value by which the shares had been priced and agreed between the parties. HMRC had not presented any factual argument to convincingly demonstrate that goodwill existed and had been separately valued and disposed of under the NCA. The share sale agreement made no reference to goodwill.  The business was that of growing tea, primarily an agricultural business. Mr Magor’s evidence was that the price per kilogram of tea was the recognised method of valuing shares.  HMRC had not established that reputation or goodwill was relevant to any degree in that type of business. There was no reason to suggest that the Board minutes referred to by Mr Magor in his evidence relating to negotiations with the purchaser and other prospective purchasers were not an accurate record of events of the manner in which the price per share was determined and in respect of which goodwill was not a factor.

18.  Although HMRC referred to the fact there were two contracts, the share sale agreement and the NCA, and that the latter was a disguised sale of goodwill this was not in reality the case. The terms of the non-competition and non-solicitation agreement were in fact embodied within the share sale agreement at schedule C and there is no significance in the fact that the NCA was completed at a later date. This is standard commercial law practice on the completion of a share sale agreement.

19. The NCA did not therefore either expressly or impliedly involve an agreement by WTH Limited not to exploit reputation or goodwill. The consideration paid for the NCA attracted the substantial shareholdings exemption under TCGA 1992 schedule 7 AC.

20.  For the above reasons the Tribunal determined that the amended assessment made by HMRC should be cancelled and allowed the appeal.

21.   This Notice contains full written findings of fact and reasons for the decision.  The Respondent has a right to apply for permission to appeal against this decision pursuant to Rule 39 of the Tribunal Proceedings (First-tier Tribunal) (Tax Chamber) Rules 2009.  The parties are referred to ‘Guidance to Accompany a Decision from the First-tier Tribunal (Tax Chamber)’ which accompanies and forms part of this Decision Notice.

22.    Mr Bramwell applied for costs on behalf of the Appellant. Under Rule 10(1)(b) the Tribunal may only make an order in respect of costs if the Tribunal considers that a party or their representative has acted unreasonably in bringing, defending or conducting the proceedings. The Tribunal reserved its decision with regard to costs and directs that the Appellant submits its application for costs to the Tribunal and the Respondents within 28 days from the release of the Decision. The Respondents shall reply within 56 days from the release of the Decision with the Appellant’s right to reply within 70 days from the release of the Decision. The Tribunal will decide the costs on the basis of written representation.

Michael S Connell

TRIBUNAL JUDGE

RELEASE DATE: 6 July 2010